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  • KPB & Co Research

Bed Bath and Beyond has been tossed in the garbage like a banana peel, as online based retailers continue to eat away market share. Over the last 5 years, online retailers saw back to back 20s + percentage growth in sales, and high single digit growth in comparable store sales, while brick and mortar retailers such as Target and Bed Bath and Beyond have seen consecutive declines in comparable store sales. The stock price of BBBY declined from a high US$76 per share in 2015 to a low of 11 per share in Dec 2018, an 85% erosion of shareholder value. This kind of slide has caused many to rename the company "Blood Bath & Beyond", a fitting name given its losing streak.

Given the deterioration in price, one would expect to see a massive deterioration in the fundamentals of the business, but on the contrary, the business remains pretty firm. The company has been facing severe challenges as a result of not anticipating the share of wallet that online shopping would eventually take, and also the role that stores have to play as they become less relevant in the traditional sense. On the other hand, the company has taken bold steps internally to address the changes in the retail landscape, and it appears that they have the wherewithal to stay out of bankruptcy while the changes play out.

Financials have Weakened But Not As Big As You'd Expect

While BBBY is trading at the lowest price seen in the last 18 years, its financial metrics are soft bu relatively solid. For one, its gross profit for FY-17 (US$ 4.4Bn) is 5X bigger than that (US$766.8Mn) 18 years prior. Gross profit margins have come down only 5 percentage points from 41.2% to 36% of revenues. In absolute terms, sales have grown substantially. Trends in gross profit margins can be used as a proxy for the level of competition that companies face in their respective industries. In a highly competitive environment, companies may effectively slash the price of their products through creative means such as offering more discounts, and free shipping. In a low competitive environment, companies do the opposite, and may even directly increase the prices of their products. Today, many other retailers are operating at lower margins than Bed Bath and Beyond and also have given up similar percentage margins, Target is at 28% and the "gorilla in the room" Walmart has a 25% gross profit margin. In our, view Bed Bath and Beyond can give up another 3-4 percentage points and still remain free cashflow positive. With a 36% gross profit margin the company generated US$484Mn in free cashflows in FY-17 and has generated US$419Mn for the first 9 months of FY-18, and currently has over US$700Mn+ in cash and equivalents. SG&A margin has been pretty much flat at roughly 29.5% of sales.

Gross Margin Wiggle Room Buys You Time

Before you reach the conclusion that we are out of our minds, let us be clear, giving up gross margins is not a viable long-term strategy, but it does buy you time to address the real issues. Bed Bath Beyond's mediocre presence in the online space reduces the attractiveness of their service offering in eyes of the customer, and so they have to make up for the slack by giving up some gross margins temporarily. At the same time, they are also investing heavily in building out a better omni channel experience, which cost a lot of money. Ultimately, we expect the company to slim down its store footprint as the leases come up for renewal which will likely take a few years to unfold. Along with a slimmer store footprint, as outlined in their Q3 investor presentation, the company is expected to reimagine the in-store experience. They have put in place about 18 stores that are directed at experimenting with visual merchandising, store layout, and operations. These stores will provide the blueprint for efficient roll out to larger number of stores later on.

It is still early to determine whether Bed Bath and Beyond has bottomed out, but the stock appears to have been beaten down too hard by the market. The company's financials remain reasonably strong given that it is still solidly free cashflow positive, and the deterioration in sales and margins have been manageable. The company still has a lot of wiggle room to tolerate more hits, while they continue to invest in the longer-term strategic initiatives that allows them to better compete in the changing retail landscape.

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